Pricing of volume-weighted average options: Analytical approximations and numerical results

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Inspired by Finance: The Musiela Festschrift, 2014, pp. 461 - 474
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© Springer International Publishing Switzerland 2014. All rights are reserved. The volume weighted average price (VWAP) over rolling number of days in the averaging period is used as a benchmark price by market participants and can be regarded as an estimate for the price that a passive trader will pay to purchase securities in a market. The VWAP is commonly used in brokerage houses as a quantitative trading tool and also appears in Australian taxation law to specify the price of share-buybacks of publically-listed companies. Most of the existing literature on VWAP focuses on strategies and algorithms to acquire market securities at a price as close as possible to VWAP. In our setup the volume process is modeled via a shifted squared Ornstein-Uhlenbeck process and a geometric Brownian motion is used to model the asset price. We derive the analytical formulae for moments of VWAP and then use the moment matching approach to approximate a distribution of VWAP. Numerical results for moments of VWAP and call-option prices have been verified by Monte Carlo simulations.
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